Oil Market Sweats Over When Russia's Cooperation With OPEC Could End

Apparently, OPEC has become "R-OPEC" with what the Russians are going to do becoming all the rage ahead of the 173rd meeting of oil ministers and the cartel’s third meeting with non-OPEC producers who joined hands with it last year to announce the ongoing 1.8 million barrels per day (bpd) crude production cut.

Bulk of the cuts are being carried out by OPEC, with its 1.3 million bpd cut largely underpinned by Saudi Arabia, while the non-OPEC share of 500,000 bpd is being carried out – at least on paper – in the main with Moscow’s support.

Yet, despite OPEC being the bigger partner in a strategy to support the price, the ongoing obsession with whether Russia is going to play along with it is fascinating for two reasons.

In the book, Al-Naimi, who influenced Saudi Arabia's energy policy making for 21 years before retiring in May 2016, wrote that past OPEC attempts to bring Russia around the table to cut crude production, almost always resulted in failure, rewinding the clock all the way back to the late 1990s.

Going back to the global financial crisis of 2008-09 and the oil market turmoil that followed in the wake of the collapse of investment bank Lehman Brothers on 15 September 2008, Al-Naimi commented that the Russians always promised but never delivered.

"The [global financial] crisis turned a retreat in oil prices into a rout...As a result, oil consumption worldwide was set to decline for the first time in 25 years."

Faced with the situation, Al-Naimi turned to Russia's Igor Sechin, then deputy prime minister and chairman of Rosneft, in the hope that the Kremlin would work with OPEC and cut output. "He agreed with me that we would both take off 300,000 bpd in production. The reductions never took place. The Russians did not follow through on their promises.

"Not only would they fail to make their agreed to cuts in late-2008... In March 2009, while Sechin would claim to be 'decreasing supplies', according to Bloomberg another Rosneft official, Peter O'Brien, would confirm that they were on target to raise their crude production by 2% compared to 2008."

Carrying on with his damning assessment, Al-Naimi wrote that five years later when oil prices started falling yet again in 2014, and there were renewed calls for cooperation between non-OPEC and OPEC producers, one of his aides quizzed him on what faith he would place on the chances of leading non-OPEC countries such as Russia, Mexico, Kazakhstan and Norway cutting oil production. "I held up my right hand and made the sign for zero."

Al-Naimi claimed that, yet again, everyone expected the Saudis to act but offered no help with sharing the burden of cuts. The sentiment was reflected in a meeting ahead of the Opec summit in November 2014, when Venezuela, a fellow OPEC member, Mexico and Russia met Al-Naimi on the sidelines expecting the Saudis to act.

Once again, others put up excuses about constraints on their ability to lower production, but this time around much to the shock of those in the room, Al-Naimi simply said: "It looks like nobody can cut. So the meeting is over" – shook hands and left abruptly. "My own team was clearly as unprepared for my response as the other ministers," he writes.

"So we left it to the market as the most efficient way to rebalance supply and demand. It was – it is – a simple case of letting the market work."

But that was then. King Salman sent Al-Naimi packing into retirement in May 2016, and his successor Khalid Al-Falih bought the Russians round to the table to underpin a 500,000 bpd non-OPEC cut.

The second reason for obsessing over Russia is, as Al-Naimi noted, do the Russians really deliver? The cut Moscow has agreed to carry out is largely down to inventory rebalancing and natural rate of depletion in the eyes of many analysts. Where it has had an impact is the sheer market symbolism of it all, i.e. two heavyweights Saudi Arabia and Russia coming together to support the price.

It is the latter that is making the market fret as the music has to stop and the crude dancing has to end. The current cut agreement is supposed to last until March 2018. Several OPEC members want this to be rolled over by nine months covering the whole of next year.

However, Russian President Vladimir Putin’s envoy and oil minister Alexander Novak – based on recent soundbites – finds it implausible to keep up the agreement or its pretense for such a long period of time.

Jason Schenker, president of Prestige Economics, says, “Moscow’s thinking is given the amount of variables the oil market has to contend with, a lot could happen in macroeconomic terms in 12 months.”

What Novak finds unconvincing, is also spooking the futures market. At 2:45 p.m. EST, Brent was down 0.53% or 34 cents to $63.27 per barrel, while WTI was down 1.09% or 63 cents to $57.36 per barrel, making it a second successive session of intraday declines extending from European to U.S. trading hours.

Yet, the Russians are cognizant of the power of symbolism, even if they are content with a $55-65 Brent price range, unlike many OPEC members.

In such a setting, Schenker says 2018 might see the Russians agree to a cut extension – craved by many in OPEC – by another three to six months, and no further. “Anything beyond that would depend on market permutations and how oil demand is shapes up over 2018.”

While Russia’s end game - to extricate itself from OPEC’s initiative at the right time - is reasonably clear, how the cartel itself gets out of a situation of its own making is anything but. Its stated aim of lowering global inventories to their five-year average is being achieved, but should the oil price nudge up to $70, more non-OPEC oil will hit the market.

And when OPEC ends the cuts, and it has to at some point, its barrels will add to increments from elsewhere. That can only mean one thing – unless demand rises significantly, supply will overshoot – a place the market has been in before.

The author is an oil & gas analyst and market commentator. Follow him on Twitter @The_Oilholic